Buy to Let - Profit or Loss?

George Osborne wiped nearly 11pc off the gross returns from buy-to-let properties, leaving many landlords facing the prospect of an annual loss, when he slashed higher-rate relief on mortgages in the Budget.

These losses could balloon further as interest costs rise. The Bank of England Governor, Mark Carney, indicated last week that the first increase was drawing closer.

The tax changes, which begin in 2017, will see landlords lose a quarter of their higher-rate relief each year until 2020, when it will be restricted to 20pc on all mortgage interest.

The National Landlords Association (NLA) has calculated that this could reduce typical yields from 4.9pc to 4.3pc for 40pc taxpayers. It could also, for example, convert an annual profit of £612 to a loss of £588 on a typical £160,000 property on which there is a £120,000 loan.

But if landlords remortgage now, not only will they protect themselves against rising borrowing costs, they may also be able to claw back shortfalls left in the wake of the tax changes. Buy-to-let has proved an increasingly popular tax-efficient investment, delivering steady income and capital growth. As other long term savings, such as pensions, have disappointed, buy-to-let loans have trebled over the past decade.

Nearly 1.7million tenanted properties have been bought with a mortgage, with the costs offset against rents, bringing tax relief at the borrower's highest rate. This will now be phased out for 40pc and 45pc taxpayers.

However, landlords can cancel out the loss of tax relief and here are some suggestions.

1. Remortgage

If a buy-to-let landlord is paying 5pc on a typical £120,000 mortgage, he might currently be earning rental income of £750 per month or £9,000 annually. After allowing for expenses, agents' fees and mortgage interest he is left with a £612 annual profit after tax.

However, when tax relief is reduced to 20pc that profit turns into an annual loss of £588. By remortgaging at, say, 3.79pc with a five-year fixed-rate loan he can save £1,452 annually on his interest bill, turning that annual loss back into a profit of £574.

Without remortgaging, his bottom line will deteriorate further as interest rates rise. Should buy-to-let loan rates reach 7pc by the time that higher-rate tax relief has completely disappeared in 2020, he will be looking at an annual loss of £2,784.

So buy-to-let landlords are likely to increasingly seek to peg their losses by fixing their rates longer where possible. Unfortunately, whereas home buyers can borrow at 3pc fixed for 10 years, a comparable 10-year buy-to-let loan will cost nearly 2 percentage points more.

2. Exploit your spouse's personal allowance

Where you do make profits, if your spouse is not working, you may be able to assign part or all of the rental income to them, allowing them to exploit their personal tax allowance, due to rise to £12,500 by 2020, or 20pc tax band.

3. Become a company

The Government is cutting corporation tax to 19pc in 2017 and 18pc in 2020, just as the buy-to-let changes bite. One way for higher-rate taxpayers to cut their tax bills might be to invest via a company. This is not difficult, and can be arranged by your solicitor. But proceed with caution, as there can be complications.

The corporation tax rate isn't the only advantage. All costs can be offset against rental income, so in theory profits may be further improved.

However, income can only be paid out to the directors as a dividend. From next April they can each receive £5,000 annually tax free. After that, dividends paid to higher-rate taxpayers are reduced by 32.5pc, while basic-rate taxpayers pay a 7.5pc dividend tax.

4. Selling property and reducing loans

The changes should prompt landlords to reassess their holdings, with a view to selling up or paying off some of the loan. Where you have a portfolio, it may make sense to sell one property and reduce the borrowings on others.

5. Raise rents

Many commentators believe rents will have to rise, although how easy that will be given recent sharp upward moves remains to be seen.